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Market Structure, Information and the Soybean Complex

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Market Structure, Information and the Soybean Complex PUTTING ON THE CRUSH ... MARKET STRUCTURE, INFORMATION AND THE SOYBEAN COMPLEX Dominic Rechner B.A. (Economics), Simon Fraser University 1987 THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF ARTS in the Department of Economics Dominic Rechner 1989 SIMON FRASER UNIVERSITY November 1989 All rights reserved. This work may not be reproduced in whole or in part, by photocopy or other means, without permission of the author. APPROVAL Name: Dominic Rechner Degree: M.A. (Economics) Title of Thesis: "Putting on the Crush" ... Market Structure, Information and the Soybean Complex Examining Committee: Chairman: S. Easton - - - fl MI-el Bowe 2 Assistant Professor Senior Supervisor of frey Poitras sistant Prof es sor V - " - Gdorge Blazenko - Assistant Professor . ~indsay-~eyedith r' Associate prof es sofi' Business Administration External Examiner Date Approved: PARTIAL COPYRIGHT LICENSE I hereby grant to Simon Fraser University the right to lend my thesis, project or extended essay (the title of which is shown below) to users of the Simon Fraser University Library, and to make partial or single copies only for such users or in response to a request from the library of any other university, or other educational institution, on its own behalf or for one of its users. I further agree that permission for multiple copying of this work for scholarly purposes may be granted by me or the Dean of Graduate Studies. It is understood that copying or publication of this work for financial gain shall not be allowed without my written permission. Title of Thesis/Project/Extended Essay "Putting on the crush" ... Market Structure, Information and the Soybean Complex. (signature) Dominic Rechner (name) 6 December 1989 (date) ABSTRACT This study explores efficiency in a speculative competitive market. From a discussion of the theoretical aspects of the efficient market hypothesis and the structure of futures markets, "disequilibrium" pricing is rationalized on the basis of market imperfections in the informational aspect of markets. Spread strategies are used to test for dependency and weak form efficiency on the Chicago Board of Trade. They are applied to daily futures prices for the commodities of the soybean complex. The results are free of sampling bias and reasonable trading \, costs are considered. The empirical results show strong evidence of pricing inefficiency in the crushing margin of soybean processors. ACKNOWLEDGEMENTS The author is extremely grateful to Michael Bowe, Geoffrey Poitras and George Blazenko for helpful comments and suggestions throughout the development of this paper and to Bruce Ramsay for assistance in data formatting. DEDICATION To Donna and my parents TABLE OF CONTENTS . Approval ................................................................................................................... 11 ... Abstract .................................................................................................................. 111 Acknowledgements ................................................................................................... iv Dedication ................................................................................................................. v List of Tables ........................................................................................................ vii ... List of Figures ..................................................................................................... vill I Introduction ........................................................................................................ 1 I1 Efficient Markets .............................................................................................. 4 I11 Weak Form Tests ............................................................................................ 6 IV Market Equilibrium ......................................................................................... 9 v Models Incorporating Diffuse Information .................................................... 14 VI Empirical Evidence ........................................................................................ 17 0.1 The Soybean Complex ............................................................... 17 0.2 Previous Studies Relevant to the Soybean Complex .............. 24 0.3 Data ............................................................................................ 25 0.4 Rule and Results ....................................................................... 31 VII Summary and Conclusion ............................................................................ 45 Notes ...................................................................................................................... 46 References ............................................................................................................... 47 LIST OF TABLES Table Page U.S. Soybeans . production. supply and disappearance ............................ 18 U.S. Soybean meal and oil . supply and distribution .............................. 20 CBOT contract details and GPM calculation ............................................. 23 Daily return specifications ............................................................................ 32 Margin requirements ..................................................................................... 36 Trading performance all strategies .............................................................. 37 Annual summaries ........................................................................................ 40 Long1 short only strategies .......................................................................... 43 vii LIST OF FIGURES Figure Page 1 Gross processing margin. 1978-1987 ........................................................... 27 2 Soybeans. 1978-1987 ..................................................................................... 28 3 Soybean Meal. 1978-1987 ............................................................................. 29 4 Soybean Oil. 1978-1987 ................................................................................ 30 ... Vlll I INTRODUCTION Basically there are two interrelated aspects of a market: transactions and information. The efficiency of a market simply refers to the efficiency with which a market performs its related functions of facilitating transactions and improving information on the terms thereof. The informational role of prices refers to the quality of information revealed through the pricing mechanism and thus relates to the efficiency with which an asset is priced. (Burns, 1983) Fama (1970, 1976) summarizes an efficient market as one in which prices always "fully reflect" available information. Although this definition stops short of defining the idea of what is meant by prices "fully reflecting" available information, Jensen (1978) clarifies this point in that "a market is efficient with respect to information set 8 if it is impossible to make t economic profits by trading on the basis of information set Bt." (P. 96) The economic profits represent risk-adjusted returns, net of all costs. There are various forms of the efficient market hypothesis which can be tested. The forms are distinguished by the class of information employed in empirical evaluations. The most commonly tested has been the "weak form" where efficiency implies that there are no economic profits offered by trading on the basis of the past history of prices. Rejection of the weak form of the Efficient Market Hypothesis requires the establishment of dependencies in the price history which can be profitably exploited. However, as Burns (1983) points out, efficiency is a variable to be explained (as a characteristic of the equilibrium or structure of the market), not an (implicit/explicit) exogenous parameter. This means that one cannot study the efficiency of a market in the framework of a specific industry structure where the development of many aspects of market efficiency are assumed away. This implies that any theoretical proposals must be based on an adequate organization of the market whose properties it is seeking to explain. It is only then that empirical studies may yield both meaningful conclusions and implications for policy purposes. Danthine (1977) and Lucas (1978) note that the many tests reported in the literature are simultaneous tests of market efficiency, perfect competition, risk neutrality, constant returns to scale and the impossibility of corner optima. The present study presents theoretical and empirical insights to the market organization of futures markets and develops an alternative to the two mainstream views of perfectly competitive markets and competitive markets with costly information. The Efficient Market Hypothesis is introduced in Section 11, followed by a critique of past weak form tests of speculative competitive markets in Section 111. The structure of the markets is discussed in Section IV where it is proposed that these markets, due to search costs and the absence of enforceable property rights with respect to informational technologies, are inherently diffuse information markets. Section V reviews recent models incorporating diffuse information and proposes that, due to the absence of enforceable property rights with respect to informational technologies, speculative capital markets will be characterized by disequilibrium pricing. The performance of opening-gap based spread strategies in the Chicago Board of Trade soybean complex
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